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The Iron Grip of Accounting IdentitiesJames Kwak responded in Baseline Scenario to some of the points that I raised in the review of the new book he co-authored with Simon Johnson, White House Burning. I want to focus on one issue in particular because it is really central to how we understand the economy.
I argued in my review that the fundamental imbalance in the U.S. economy is the trade deficit. This deficit is in turn caused by the over-valued dollar. The latter is a direct result of the decision of developing countries to accumulate massive amounts of foreign exchange reserves (i.e. dollars) in the wake of the East Asian financial crisis.
Developing countries saw the harsh treatment of the East Asian countries following the crisis and decided that they did not want to be in the same situation. Their protection against this event was the stockpiling of huge amounts of reserves. They acquire the reserves by running trade surpluses, which they use to acquire dollars. The decision of foreign central banks to buy and hold dollars keeps up the value of the dollar against their own currencies. If they didn't buy dollars, the value of the dollar would fall relative to their currencies.
This matters for our trade deficit because the higher valued dollar means that imports are cheaper for us, which leads us to buy more imports. In addition, the high dollar means that our exports are more expensive for people in other countries. Therefore they buy less of our exports. If we import more and export less, then we get a trade deficit.
This matters for the budget deficit story because if the United States runs a trade deficit, then it means that the United States has negative national savings. This is definitional; as a country we are buying more than we are selling.
Dean Baker / March 28, 2012
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Latin America and the Caribbean
Change is Gonna Come: For the First Time, Global Health Expert Nominated by U.S. for World Bank PresidencyDeborah James / March 26, 2012
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Latin America and the Caribbean
Obama y Clinton ignoran los llamados para poner fin a los asesinatos en HondurasMark Weisbrot / March 26, 2012
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The Paul Ryan Rorschach TestDean Baker / March 26, 2012
report informe
Affording Health Care and Education on the Minimum WageCEPR, and / March 26, 2012
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Affording Health Care and Education on the Minimum WageJohn Schmitt, and / March 26, 2012
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Krugman Nails It! Problem Is Crony Capitalism, Not Free Market FundamentalismDean Baker / March 26, 2012